Income Statement

The balance sheet is different. The SEC guide states that balance sheets show what a company owns and what it owes at a fixed point in time. The income statement therefore reports what happened during a period, and the balance sheet reports where the company stood at one date.

The guide names the other primary statements. Cash flow statements report a company's inflows and outflows of cash. The statement of shareholders' equity shows changes in the interests of the company's shareholders over time. Together with the income statement and the balance sheet, these are the four financial statements that the guide describes.

Revenue

The first line is revenue. The SEC's small business material defines revenue as the value of the products or services sold. The SEC guide describes it as the total amount of money brought in from sales of products or services, and says that this top line is often referred to as gross revenues or sales.

Regulation S-X, the SEC's regulation on the form and content of financial statements, uses the caption net sales of tangible products and describes it as gross sales less discounts, returns and allowances.

Cost of Sales and Gross Profit

After revenue, the statement subtracts the direct cost of what was sold. The SEC guide states that the next line after net revenues typically shows the costs of the sales. The SEC's small business material describes cost of goods sold as reflecting the direct expenses the entity incurred to produce the products it sells. Regulation S-X uses the caption cost of tangible goods sold.

The result is a subtotal. The SEC guide calls it gross profit, or sometimes gross margin. Gross profit is therefore revenue less the direct costs of sales, before the costs of running the rest of the business.

Operating Expenses and Operating Income

The statement then deducts the costs of operating the business. The SEC's small business material states that operating expenses, also called selling, general and administrative expenses, include the overhead costs of running the business that are not associated with the costs to produce products. The SEC guide describes operating expenses as expenses that go toward supporting a company's operations for a given period, and gives as examples the salaries of administrative personnel and the costs of researching new products. It also states that depreciation is deducted from gross profit. Regulation S-X uses the caption selling, general and administrative expenses.

The result is operating income. The SEC guide states that this is often called income from operations. FINRA's article on performance metrics states that EBIT is also known as operating profit, and it describes operating margin as EBIT divided by total revenue, which shows how much income is generated by each dollar of sales.

Interest and Income Taxes

Two more deductions follow. The SEC guide states that interest expense is the money companies paid in interest for money they borrow, and the SEC's small business material describes interest expense as the amount of money the entity owes or paid to its lender under a loan obligation.

Income tax comes last. The SEC's small business material states that income tax expense is an estimate and reflects the amount of money the entity owes to the government. The SEC guide describes the step this way: income tax is deducted and you arrive at the bottom line, net profit or net losses. Regulation S-X provides a caption for income or loss before income tax expense, and a separate caption for income tax expense in which only taxes based on income are included.

Net Income

The final line is net income. The SEC's small business material describes net income, or loss, as the amount of profit the entity made or loss it incurred after subtracting all its expenses. FINRA's article states that, perhaps the most basic profit measure, net income is what remains when total expenses are subtracted from total sales, or revenue.

Regulation S-X has a rule for commercial and industrial companies that is titled statements of comprehensive income, so a financial statement filed with the SEC may carry that title rather than the title income statement. The next section describes the captions that rule lists.

The Line Items in Regulation S-X

The rule states its purpose in terms of line items. It indicates the various line items which, if applicable, and except as otherwise permitted by the Commission, should appear on the face of the statements of comprehensive income. The captions it lists, in order, are net sales and gross revenues; costs and expenses applicable to sales and revenues; other operating costs and expenses; selling, general and administrative expenses; provision for doubtful accounts and notes; other general expenses; non-operating income; interest and amortization of debt discount and expense; non-operating expenses; and income or loss before income tax expense and appropriate items below.

The list continues with income tax expense; equity in earnings of unconsolidated subsidiaries and 50 percent or less owned persons; income or loss from continuing operations; discontinued operations; and net income or loss. It then lists net income attributable to the noncontrolling interest and net income attributable to the controlling interest, followed by other comprehensive income, comprehensive income, comprehensive income attributable to the noncontrolling interest, comprehensive income attributable to the controlling interest, and earnings per share data.

The rule also provides that the equity-in-earnings caption may be presented in a different position and manner if the circumstances justify it.

Earnings Per Share

Earnings per share, known as EPS, expresses net income on a per-share basis. The SEC guide states how it is calculated: take the total net income and divide it by the number of outstanding shares of the company. Investor.gov defines it as a public company's net profit divided by the number of its common shares. FINRA describes it as the measure of a company's profitability per outstanding share of common stock, and notes that two EPS measures are often seen at the bottom of an income statement.

FINRA also describes the price-to-earnings ratio, which is calculated by dividing the stock price by its EPS. Earnings per share is therefore a figure drawn from the income statement, and the price-to-earnings ratio combines it with a market price.

How the Income Statement Relates to the Other Statements

The statements are linked. The SEC guide states that the cash flow statement reconciles the net income shown on the income statement to the actual cash. The guide also states that the shareholders' equity shown on the balance sheet reflects the company's earnings or losses since inception.

Where Income Statements Appear

Investor.gov states that a public company's annual report on Form 10-K is filed annually and that its financial statement section contains the company's audited financial statements, including the income statement, balance sheets and statement of cash flows.

The quarterly report on Form 10-Q is different. Investor.gov states that each quarter public companies file reports with the SEC, containing unaudited financial statements and information about the company's operations in the previous three months.

Regulation S-X states how many years an annual filing must cover. Its rule on consolidated statements of comprehensive income and cash flows calls for audited statements for each of the three fiscal years preceding the date of the most recent audited balance sheet. The same rule allows an emerging growth company to provide two fiscal years in a registration statement for its initial public offering, and states that interim financial statements may be unaudited.

The 10-K also contains management's discussion and analysis. Investor.gov describes it as the company's view on the business results of the past fiscal year, which allows company management to tell its story in its own words.

Results also reach the market outside the periodic reports. Item 2.02 of Form 8-K applies when a company makes a public announcement or release disclosing material nonpublic information regarding its results of operations or financial condition for a completed quarterly or annual fiscal period. The form's general instructions state that information furnished under that item is not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 unless the registrant specifically states that the information is to be considered filed or incorporates it by reference into a filing. They also state that, unless otherwise specified, a report is to be filed or furnished within four business days after the occurrence of the event.

Non-GAAP Measures

Companies sometimes present measures that are not calculated in accordance with generally accepted accounting principles. The SEC regulates these in Regulation G. The regulation applies whenever a registrant, or a person acting on its behalf, publicly discloses material information that includes a non-GAAP financial measure. The registrant must accompany the disclosure with a presentation of the most directly comparable financial measure calculated and presented in accordance with generally accepted accounting principles, and with a reconciliation of the differences between the two. The regulation also provides that a registrant may not make public a non-GAAP financial measure that, taken together with the information accompanying it, contains an untrue statement of a material fact or omits to state a material fact necessary to make the presentation not misleading.

The SEC staff's published interpretations address EBIT and EBITDA directly. They state that if a company presents EBIT or EBITDA as a performance measure, the measure should be reconciled to net income as presented in the statement of operations under generally accepted accounting principles. FINRA's article describes EBITDA as a measure that strips out interest, taxes, depreciation and amortization, and says that it adds back depreciation and amortization, which are non-cash expenses.

Ratios Drawn From the Income Statement

Several ratios use figures from the income statement. The SEC guide describes the operating margin as a ratio that compares a company's operating income to net revenues. FINRA's article defines operating margin as EBIT divided by total revenue. The SEC guide describes the inventory turnover ratio as one that compares a company's cost of sales on its income statement with its average inventory balance for the period, and the price-to-earnings ratio as one that compares a company's common stock price with its earnings per share.

Footnotes and Management's Discussion

The SEC guide has separate sections titled Read the Footnotes and Read the MD&A. It states that the footnotes to financial statements are packed with information. It states that the MD&A is intended to help investors to see the company through the eyes of management. FINRA's article likewise advises readers not to ignore the footnotes in financial statements, because they sometimes contain important information.

Reading an Income Statement

FINRA's investor education material describes how investors use the statement. It says the income statement helps reveal a company's growth and profitability, and that investors can compare a company's results with those of its peers. It states that investors can calculate various sales and profit margins that quantify a company's performance.

FINRA states that even a profitable company can run into liquidity problems if it does not generate enough cash to pay its bills. The same material contains cautions about comparisons. FINRA's article states that tax structures and interest expenses vary from company to company, which is why EBIT helps comparisons, and that operating margin is best used when comparing a firm's performance with its peers.

Common Misunderstandings

One misunderstanding is that the income statement shows what a company has on a given date. The SEC guide states that balance sheets show what a company owns and owes at a fixed point in time, while the income statement covers a period.

A second misunderstanding is that revenue and profit are the same. Revenue is the value of the products or services sold, and net income is what remains after subtracting all the expenses.

A third misunderstanding is that gross profit and net income are the same. Gross profit is the subtotal after the costs of sales, and net income comes after operating expenses, interest and income taxes.

A fourth misunderstanding is that net income is the cash a company received. The SEC guide states that the cash flow statement reconciles the net income shown on the income statement to the actual cash.

A fifth misunderstanding is that a profitable company cannot have cash problems. FINRA states that even a profitable company can run into liquidity problems if it does not generate enough cash to pay its bills.

A sixth misunderstanding is that earnings per share is a stock price. EPS is net profit divided by the number of shares, and the price-to-earnings ratio is the stock price divided by EPS.

A seventh misunderstanding is that every income statement a public company files is audited. The annual report on Form 10-K contains audited financial statements, and the quarterly report on Form 10-Q contains unaudited financial statements.

An eighth misunderstanding is that an earnings press release is a filed document. Form 8-K states that information furnished under Item 2.02 is not deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934 unless the registrant specifically states that it is to be considered filed or incorporates it by reference into a filing.

A ninth misunderstanding is that a company may present a non-GAAP measure alone. Regulation G requires the most directly comparable GAAP measure and a reconciliation to accompany it.

A tenth misunderstanding is that the statement is always titled income statement. Regulation S-X has a rule titled statements of comprehensive income, and the SEC's small business material notes that it is sometimes called a profit and loss statement.

Key Points

The income statement reports a company's revenue, expenses and net profit or loss over a period, usually a year or some portion of a year.

Its lines run from revenue, through cost of sales and gross profit, operating expenses and operating income, then interest and income taxes, to net income.

Earnings per share is net income divided by the number of outstanding shares, and FINRA notes that two EPS measures are often seen at the bottom of an income statement.

The balance sheet shows a fixed point in time, the cash flow statement reconciles net income to actual cash, and the statement of shareholders' equity shows changes in shareholders' interests over time.

Form 10-K contains audited financial statements and Form 10-Q contains unaudited ones, and Regulation S-X calls for three fiscal years of audited statements in an annual filing.

Regulation G requires a company that publicly discloses a non-GAAP measure to present the most directly comparable GAAP measure and a reconciliation.